Predictably Rational: A Brilliant Book by Richard B. McKenzie

This is the time of the year that various publications recommend Christmas books or the best books of 2010. (I have never known what a Christmas — or summer — book is. Are they supposed to be light reading? I don’t believe in reading “light.” When I am in the mood for that, I watch TV.) In any event, I have a serious book to recommend.

Every so often a brilliant book comes out on a topic of great academic importance that is in danger of not getting the attention it deserves. I am thinking about Predictably Rational: In Search of Defenses for Rational Behavior in Economics by Richard B. McKenzie. I have never thought of McKenzie as a methodologist or theorist but as an excellent applied economist. This book shows clearly that he can be all of these things. (See his webpage here.)

The cover of McKenzie’s book looks a lot like Dan Ariely’s Predictably Irrational: The Hidden Forces That Shape Our Decisions. I am not sure if this was a wise decision by the publisher (Springer) or not. In some ways McKenzie’s book is an antidote to the Ariely perspective. But McKenzie’s book is more the book for economists. He writes in our language and addresses our issues. It is also methodologically more astute than Ariely’s book because McKenzie deals with the fundamental issue of whether we should want greater psychological realism in economics.

I am not going to try to summarize McKenzie’s conclusions because I have not yet finished the book but I already have read enough know that it is a highly insightful and important book. His treatment is from several perspectives: the history of economic thought, the philosophy of science, and recent developments in economics, especially behavioral and neureoconomics. (Take a look at the Table of Contents here.) Of particular interest to readers of this blog, he insightfully discusses the ideas of Mises, Hayek, Buchanan and the two Smiths.

I have become very interested in the topic of rationality in economics in the past few years. Some of the major challenges to the rationality postulate in standard economics have come from quarters advocating a new paternalism. They have argued that because individuals engage in systematic and predictably irrational behavior we cannot be sure that the free choices of these individuals will enhance their well-being. “Thus,” the state ought to incentivize (or nudge) behavior in a better direction.

As many readers of this blog know, Glen Whitman and I are writing a book for Cambridge University Press on the new paternalism. I expect that McKenzie’s book will be enormously helpful in this task. But for all economists it is vital to understand, better than we have, the role of the rational-behavior postulate in economics. McKenzie’s book is the place to explore the matter deeply.

Of course, Mises points out that when it comes to action, no action aiming at a goal can be irrational, but only rational. It may be misinformed, but being misinformed is not being irrational. This of course does not speak to the rationality of one’s goals. One can have an irrational goal and use rational means to try to achieve it. I fear that too many mistake being misinformed with being irrational when it comes to action. One’s goals may of course be either rational or irrational. And then there is the issue values ranking. I suspect that more often than not people are really complaining about others’ value rankings and whether another’s value ranking are the same as theirs — i.e., “rational.”

Richard McKenzie’s book is well worth reading. Rationality in the real world is a very different beast from the rationality of homo economicus, and most of what behavioral economics takes for irrationality (heuristics/biases) are entirely rational ways of dealing with irreducible uncertainty. Both neoclassical economics and behavioral economics share a flawed definition of rationality at their core. McKenzie discusses Gerd Gigerenzer’s work which is excellent, especially his book “Rationality for mortals: how people cope with uncertainty”.

In my opinion, more psychological realism in economics is essential. Gigerenzer’s key contribution is to elaborate that real-world rationality in genuinely uncertain situations is not a shortcut to the rationality of economics textbooks – in fact, it looks nothing like the rationality of homo economicus. In the face of true uncertainty we cannot and do not “optimise” – we explore and probe and use various heuristics gleaned from experience and the past to cut through the fog of uncertainty. I’m not trying to say that optimising models have no place but the set of economic questions where uncertainty does not matter is miniscule. The problem of course is that a more honest definition of rationality leads to messier conclusions and it requires that we abandon equilibrium modelling.